by refurbishing assembly plants. why, then, would they spend $500 million on radical newlant?w coulans why, then, would they spend worth $300 million? a fundamental incentive of our economic system is to make money. it is why we work, save, invest, and take risks. individuals and institutions alike want to maximize the money they can get from the marketplace. profits and interest-- how do you get the best return? with economic analyst richard gill, we'll investigate that question on this edition of economics usa. i'm david schoumacher.
the church first decreed that charging for the use of money was sinful. the concept of usury and its immorality is found in the bie. by the middle ages, it was churclaw. usury came to mean excessive interest rates. limiting rates to reasonable levels was adopted as government policy. what caused that policy
to work against people it was designed to protect? for 100 years, maryland financial institutions lived with laws setting usury ceilings. because interest rates on home mortages stayed below these ceilings, few problems arose. homeowners got mortgages. lenders got an acceptable rate of return. t thenin the 1970s, inflation ove interest rates up. financial institutions wereaced with paying higher interest rates to deposito than they earned through home mortgage loans. baltimore banker douglas dodge explains. in that period of time, interest rates generally we rising, reflecting the value of money really all over the world. the yield available to banks and thrift institutions, insurance companies, who traditionally may have made mortgage loans or purchased mortgage loans, became unattractive relative to other investment alternatives.
as economic conditions changed, maryland's banking community began to look elsewhere for investments. money that normay went into home mortgages went shopping for highereturns and large new york frommoney maet funds.deposits while iselped the financial institutio, it devastated maryland's housing industry. maryland home builder frank miano felt the pressure personally. take a small builder who had a few spec houses that were sitting. he was paying interest on those. it's a question of staying power. how long can you maintain that unit until it's sold? miano's losses on houses temporarily forced him from the business. we sold some houses at a loss to get out from under the construction loans weinallyid sell them.
as lenders cut back home mortgages, new home buyers and sellers became frustrated. even the resale market was affected. maryland wasn't the only state troubled. 18 others had interest rate ceilings. usury laws placed such a strangle hold on housing money that congress wanted to ban them. pressures to change the law mounted. senator laurence levitan sponsored the bill to raise usury limits. we weren't only hearing from lenders and developers during the interest crunch, where the interest rate hit and went above the ceiling. we heard from the average citizen who wanted to buy or sell his house. the ceiling prevented them from entering the marketplace. senator julian lapides opposed lifting the ceiling. when people need or want money,
they're unconcerned about the cost at that moment. and that's why the state has to be almost in place of the parent. we have to really be responsible to protect the public from themselves. the bill passed easily, clearing both houses by february 21, 1979. governor hughes signed it the next day. what happened? mortgage interest rates went to 12%, then gradually came in line with rates across the nation. so we had frozen these people in their property. they couldn't move. they couldn't sell. once we raised the ceiling, that changed. people could sell their houses and did. money flowed into maryland. i think the consumer lost badly that year and subsequent years when we removed all limits in maryland. and i think that the public has been damned.
it's no different than any other commodity. if there's a shortage of sugar, the price of sugar will go up. if there's a coffee shortage, its price will rise. if there's a money shortage, its cost rises. maryland's raising of usury ceilings ended the crisis. interest rates increased, but mortgage loans became available. economic analyst richard gill explains the limits on the government's control of the rate of return on investments. sometimes good intentions produce counterproductive results. the philosophy behind usury laws is honorable enough. borrowers are often people in need. they can be taken advantage of by lenders. however, money, in the form of loanable funds,
is subject to supply and demand as is any other commodity. the demand for loanable funds depends on the interest rate. the lower the rate, the more builders, developers, and potential homeowners who will want to borrow money. on the supply side, the savings and loan and other lending institutions will look for the highest rate of return on their loans. if they can't get it in a particular area, they'll look elsewhere. the higher the interest rate, the greater the supply of forthcoming loanable funds. in this diagram, supply and demand are equated at an interest rate of 15%. maryland's law said, "you can't charge 15%, only 10%." they put a ceiling on interest rates and reduced the supply of loanable funds.
this meant many people happy to borrow at 10% couldn't find lenders. more significantly, the supply for mortgage money, and thus new homes, was reduced below what would otherwise have been the case. a few people got good deals. many could not build homes at all. good intentions-- maryland's road to new homes was not paved with them. for over 50 years, general motors assembled its products at this detroit plant. it has seen military production, postwar prosperity, and the pressure of foreign competition. millions of cars have been made here. so why, after all those productive years, did gm move somewhere else? the nation's largest automaker wanted the quickest possible return
on capital investments, plants and equipment. gm planners wanted new assembly plants to start returning profits in five years. as auto industry analyst maryann keller explains, this system worked with strong sales of large american cars. general motors always had a higher return on investment because they produced the largest cars and dominated that segment of the market. automotion. america on the move, a tremendous display. during the 1950s and 1960s, boom years for american automakers, gm had a 20% yearly return on equity. to keep the old plants efficient, plant managers fine-tuned production processes. if sales were strong and profit margins wide, gm could cover the inefficiency of old age in its assembly plants.
then, in the 1970s, several events cracked the comfortable cocoon of general motors. a series of oil shortages, government regulations, and changing consumer preferences shook the foundations in detroit. every fourth u.s. car was now foreign made. journalist david davis recas that gm got the message from its dealer network. not only could a gm dealer not sell enough cars to pay his bills, but down the street, there was toyota dealer who was successfully selling cars. a mercedes benz dealer selling $35,000 cars couldn't get enough. but the guy selling oldsmobiles, pontiacs, buicks, and chevrolets couldn't move a car to save their lives. it was a very sobering moment. in 1980, general motors,
america's symbol of blue chip profitability, reported an annual loss. it was the company's first since 1921. did gm know a changing market meant carmaking changes? robert stempel is the executive in charge of gm's buick, oldsmobile, and cadillac division. things like the energy crisis, oil availability, meant our products needed to get hundreds of pounds lighter. engines had to get more efficient. things we'd given away as we controlled emissions or safety we had to regain. that meant looking at the process that had served us for 60 years. for gm, switching to new plants involved weighing tradeoffs. was it the best place to invest? obviously, your rate of return should be better than that in the banking industry.
our country has gone through some good returns on money. so the hurdle rate, the good return on investment, was a key decision. the plant's usable life was many years. we had to think about this decade and beyond. the indecision ended in 1981. gm chairman roger smith announced a 10-year, $80 billion expansion program which included construction of assembly plants. the orion plant, north of detroit, represented the strategy's first wave. gm spent $500 million on a plant when the prime interest rate was 14%. inside the 77-acre building, gm puts together cadillacs and oldsmobiles, making extensive use of computers and robot technology. at full production, the orion plant makes 75 cars hourly.
obviously, it was faster, but was it a better way? plant manager leslie richards. we build cars with greater accuracy than ever before because of the new tooling and the robots. it isn't possible to operate a plant this size without our material-management computer systems. 9,500 different part numbers are kept track of here daily. gm's orion plant is state of the art, at least for now. cleaner and brighter, it's a better place to work, even if it's where fewer humans are needed. but is it profiting? gm hopes for a 15-20% rate of return on its plants. it usually takes at least 12 months before you're running at full speed and running everything to maximum efficiency.
gm is probably close at winsfield and lake orion to achieving those returns. financially, is it starting to pay off? yes, the time it takes to build a car in that new plant is less than in our old plant. our bet that we could become more productive is paying off. many felt gm had to build plants like orion. it was modernize or be run over by the auto business of the 1980s. how does gm, or any business, decide what will be profitable? we asked economic analyst richard gill. essentially what gm had to do in considering this investment was to compare the expected rate of return with the cost of money needed to finance the investment--
the interest rate. how does one calculate this expected rate of return? let's consider a simple case. a firm is considering putting $1 million into a new piece of machinery. this machinery lasts only a year. during that year, the businessman expects this machinery will add enough to output to increase revenue by $1.2 million. the ra of return is 20%. the way we would calculate it is by this formula. r is the expected rate of return. in numbers... if the interest rate is below 20%,
the investment will be profitable. if it is above 20%, it will be unprofitable. in real life, it is more complicated. the new plant and equipment would last many years. guessing the expected rate of return was difficult. still, calculations like this shows us the general way the rate of interest affects investment decisions. the higher the rate of interest, the smaller the number of investments that make it to fruition. had interest rates been too high, gm's orion plant would never have been built. the most impressive thing about early computers was their size. today you can do more work faster than the 1950s version of a computer with microprocessors or computer chips.
in 1976, two californians took a gamble on computer chips. in four years, they were multimillionaires. what did they do to earn such a high rate of return? steve jobs dropped out of college, studied eastern religions, designed video games for atari. i received a letter from a 6-1/2-year-old boy which sums up what we've accomplished. "dear mr. jobs, "my crossword puzzle clue was, as american as apple... "i thought the answer was computer, but mom said it was pie." steve wozniak won a science fair at 12, designedomputers in high school, and raised money to build one six years later. i took it with my tv to the club and demonstrated to everybody.
"look how small this is, and i built it myself." atari's founder, nolan bushnell, recalls a video game they created. i had one project that everyone turned down. it was a game called breakout. finally i said, "steve, hey, do this for me." and he said, "done." wozniak wasn't on the payroll and jobs was. they worked something out in the evening. two weeks later, in a project that traditionally took months, we had a prototype. in january 1976, jobs, the promoter, began pestering wozniak, the designer, to build some printed circuit boards so other hobbyists could build their own computers. we invested $1,000 and we'd have to sell 50 to profit.
i said, "i don't think we'll get our money back." he said, "no, maybe we won't, but we'll have a company." if you're like me, that's reason for doing something. you don't have to justify it in some productive sense. we started as just a little play dream. for start-up capital, jobs sold his van and wozniak his calculator. soon they had a prototype. i took this blank pc board to hewlett-packard and showed it to my engineer friends. everyone was gloating over it. a few days later, steve called me at work. he's all excited and says, "i got a $50,000 order." that order came from the byte shop, one of silicon valley's first computer stores. jobs used it to get parts for the apple i.
jobs' parents' garage, where the first apples were assembled, has entered entrepreneurial folklore as the log cabin birthplace of the personal computer. here wozniak tested the apple i and future models. jobs wrote advertising and managed the money. the characterization that steve jobs was the marketeer, the promoter, was absolutely true and that steve wozniak was the technologist. jobs really forced the company to happen. he solved the problems. he hired the people. he made sure the company was pushed into a real organization. and of course, mike markkula also helped a great deal. marketing expert markkula was so impressed with the computer, he took money he'd made at intel and provided capital in return for partnership.
the threesome began developing the apple ii for a 1977 computer fair. we got the units the day before. we carved off the excess shavings on them, made them look presentable, put our boards in, and it was a working apple ii. journalist michael moritz wrote a history of apple. he dcreshow plstolthe show. they h logoshoted higher th. th h the iression of an established booth, though it was just drap with crpaper. it was, as they say inicon valley, an ord of magnemore advan. though oy threcomputers we at thfa, the company soon took orders for 300. markkula's comment after the show was,
"we're going to be a $500 million company." that breakthrough led to full-scale production. the handful of employees moved to cupertino and launched an advertising campaign. apple ii's design set it apart from competitors. first, it was expandable. owners could add circuit boards to run printers or speech-boxes. the computer had more memory capacity, so it could run complicated programs like visicalc. when wozniak produced a disk drive, it revolutionized the way information was entered and stored. apple developed a floppy disk that they could market. it put them ahead of the pack. by september 1980, the apple ii dominated the personal computer market, used at home for fun and profit, in offices for word processing, financial calculations, and in schools
to educate and entertain. 130,000 were sold. the company had 1,000 employees in plants from ireland to singapore. annual sales hit $300 million. apple's success led to growing interest in its stock as the company prepared to go public. it's clear that for underwriters and investors, in the fall of 1980, the prospect of an apple public offering seemed like the second coming. the people who had stakes in the company, those underwriting it, those who invested, would see three lemons on the slot machine. apple stock was snapped up by the public, making it the largest initial offering since ford went public. in addition to raising cash, the offering rewarded employees and investors handsomely. the big winners were apple's founding entrepreneurs,
steve jobs and steve wozniak, who had, in a short time, become multimillionaires because of their creation. it was rather astounding. it was one of the finest products ever that deserved to be such a winner. you couldn't have looked ahead and expected it. of those who turned inventions into fortunes in silicon valley, none did it as spectacularly as apple's founders. but are such huge profits justified? what's their role in a market economy? we asked analyst richard gill. large profits in a capitalistic system, according to economist joseph schumpeter, derive from one source-- innovation. they're the superabundant rewards given to those who are clever enough, daring enough, enterprising enough,
to come up with something new. the apple computer story is a letter-perfect example of what schumpeter was talking about. a few points about this process-- first, innovation decisions are quite different from the expected rate of return calculations we discussed earlier. how can you calculate a rate of return when you're doing something new? it's doubtful the interest rate plays any major role here. second, the entrepreneurs weren't risking big money. they sold a van and a calculator. their risks were far more subtle, a sense of failure, perhaps, reputations, schumpeter might have said. third, the huge profits did not last that long. ibm and all their brotherhood quickly swooped down into the personal computer market. entrepreneurial profits are often huge,
but also transitory. the swarm follows the leader. this was part of schumpeter's description. schumpeter's general conclusion? these enormous, short-lived profits are justified by the benefits innovation brings. given the dominant role that innovation has played in american economic growth, it's difficult to disagree. huge profits can represent monopoly and distortion, but they also can be the oil that lubricates the wheels of progress. of the thousands of people who start new firms every year in this country, most will fail. financial institutions, large corporations, and individual entrepreneurs must calculate probabilities for failure and success. we're propelled by the marketplace to invest our time and money in those ventures offering the best chance of return.
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